Overnight Reverse Repurchase Agreement Facility (ON RRP)

The Overnight Reverse Repo (ON RRP) facility is a monetary policy instrument used by the Federal Reserve to regulate short-term interest rates and oversee market liquidity. It involves transactions between the Federal Reserve and qualified financial institutions, including banks, money market funds, and other institutional investors.

In an overnight reverse repo transaction, the Federal Reserve sells Treasury securities to eligible financial institutions with a commitment to buy them back the following day at a set price. Essentially, the Fed is borrowing cash from these institutions overnight, providing Treasury securities as collateral.

The interest rate that the Fed pays on these transactions is known as the offering rate, which is established by the Federal Open Market Committee (FOMC). This rate acts as a lower limit for short-term interest rates, impacting overall market rates.

The ON RRP is crucial in influencing market liquidity and ensuring stability in the money markets. Its impact on market liquidity includes:

• Drains Excess Reserves: By enabling financial institutions to lend their surplus reserves to the Federal Reserve, the ON RRP helps eliminate excess liquidity from the banking system, thereby decreasing the total amount of reserves available for lending in the money markets.
• Establishes a Floor on Short-Term Interest Rates: The ON RRP offering rate serves as a minimum for short-term interest rates, ensuring that financial institutions do not lend in the market at rates lower than what they can earn through the ON RRP.
• Stabilizes Money Market Rates: During times of market stress or volatility, the ON RRP can help stabilize money market rates by providing a risk-free investment option for financial institutions, thereby minimizing the risk of disruptions in money market rates.
• Complements Other Monetary Policy Tools: The ON RRP operates alongside other monetary policy instruments, such as the interest rate on reserve balances (IORB rate), to maintain control over short-term interest rates and manage liquidity conditions in the financial system.